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Sick Pay Plans: Does ERISA Care?

Posted in Welfare Plans

As of November 30, 2009, 15 states had proposed mandatory sick-leave laws to require employers to provide paid sick days to employees.  San Francisco, Milwaukee and Washington DC have municipal ordinances that require some mandatory sick leave and the New York City council has proposed similar regulation.  Federal regulation was proposed on both the Senate and the House of Representatives.  The purpose of this entry is not to survey the state or cities that have adopted these regulations, and if you have concerns that you might be subject to mandatory sick leave laws, I encourage you to reach out to your attorney at Fox Rothschild and make sure you are in compliance.

Instead, I am looking at whether an employer can create a "sick pay plan" to satisfy the obligation to pay sick days and create an ERISA governed welfare plan.  Such a plan might be beneficial for an employer for tax purposes or administrative purposes, or it might be part of preserving employee good will.  Under IRC sections 105 and 162, a business cannot deduct wages paid to a disabled employee.  The key word is wages.  IRC section 106 requires that a company pay wages only to employees who render services.  However, a company can pay wages to disabled employees under a section 105 qualified sick-pay plan (QSPP).

Generally 29 CFR 2510.3-1 provides that the definition of "employee welfare benefit plans" in Section 3(1) of ERISA does not include arrangements that pay an employee’s normal compensation, out of the employer’s general assets, on account of periods of time during which the employee is physically or mentally unable to perform his or her duties, or is otherwise absent for medical reasons.  This "sick pay" exclusion is designed to exempt from ERISA requirements payroll and employment practices when the benefits are uninsured and paid out of the employer’s general assets, such as vacation pay, holiday pay and short-term disability pay or sick leave.

Generally we can assume that disability plans, when funded through insurance, are probably ERISA plans.  But what about a truly "short term" type of benefit that provides compensation for something like 5 missed work days?  Going back to PWBA Advisory Opinion 96-16A (8/27/1996), the DOL looked at a three phase disability plan that provided compensation replacement coverage for three disability periods: really short (5 to 10 days), short (11 days to one year) and long term (more than one year until retirement).  The plan replaced compensation where absences was due to illness or injury.  The plan was unfunded and paid out of the general assets of the company, but the Company retained discretion to pay benefits through a group disability income insurance policy, a trust or a separate account.

The specifics of this plan are not so interesting as the DOL’s decision that the entire arrangement was not a "payroll practice" within the meaning of 29 CFR 2510.3-1.  But what if "phase one" coverage (5-10 days) was separated out?  Would that sick-pay arrangement have qualified?  What about a sick pay plan covering days 1-4?  In this case, I believe the answer lies somewhere closer to our analysis of severance plans and the determination of whether they should be treated as ERISA plans.  For example, we look to things like the funding arrangement and the ongoing administrative requirements.  An employer who pre-funds sick pay at the beginning of the year, or sets aside a trust from which sick-pay benefits are paid may be creating something outside the payroll function.  If the sick pay arrangement requires some additional administration beyond a simple payment of wages (such as cost of living adjustments or eligibility requirements) would appear to look more like a "plan" rather than a payroll practice.

Ultimately this brings me back around to Qualified Sick Pay Plans (sometimes referred to as "salary continuation plans") under IRC Section 105.  These plans solve the issue by creating an ERISA plan that provides for sick pay.  As with other ERISA plans, you have to have appropriate documentation and administration.  It has to be funded in some fashion and can be done through the purchase of insurance. A Qualified Sick Pay Plan may also permit a business owner from paying himself (or herself) a salary while disabled, and then deducting the payments allowable business expense.

So if you are in a jurisdiction considering mandating sick pay, it might be worthwhile for your company to consider a Qualified Sick Pay Plan, not as a means of avoiding the law, but as a means of using this framework to minimize potential negative financial impact of those laws.